China moves to make yuan global currency

http://www.domain-b.com/finance/general/20081226_yuan_global_currency.html

26 December 2008

Armed with a staggering $1,89 trillion in foreign exchange reserves, the Chinese government announced the first step towards making the yuan, its currency, an international currency, by allowing it to be used as a mode of payment in business deals with some neighboring countries. The move would also curb the effect of the volatility of the dollar on trade settlements.

With trade settlements being done mainly with the dollar and also the euro, the yuan, currently not a freely convertible currency, this pilot project will be first tested by allowing the yuan to be used to settle trade payments between the delta regions of China's Pearl and Yangtze rivers and the special administrative regions of Hong Kong and Macau.

The Guangxi Zhuang autonomous region and Yunnan province will be allowed to use the yuan to settle trade payments with ASEAN countries like Thailand, Laos, Burma, Malaysia, the Philippines, Singapore, Cambodia, Brunei, Vietnam and Indonesia.


However, the Chinese government did not specify how and when the pilot project would start.

The recession in the US, Japan and many EU nations, led to decline of China's exports declined by 2.2 per cent in November, the first decline in more than seven years. Chin now plans to boost its sagging export sector by allowing the yuan to settle trade payments with neighboring countries along with a series of other measures.

After a meeting of China's State Council yesterday, the cabinet released a document announcing a raft of more measures to encourage domestic spending by doling out more subsidies for buying household appliances and other merchandise to the rural people and increasing the number of stores and distribution centres in the hinterland.

The government will also renovate the urban food markets, provide more variety of goods, build new second-hand markets, encourage distribution companies to merge and consolidate by giving them more incentives, and shore up small and medium-sized business.

Export tax rebates for high-technology products will be hiked, foreign investment will be encouraged and lower the inspection fee for exports.

As ASEAN countries, Hong Kong and Macau constitute 20 per cent of mainland China's total trade volume and has reached $402.7 billion last year, Zhou Xiaochuan, governor of the central bank said last month that trade settlements using the dollar is not feasible due to the high volatility of the dollar and once the yuan is accepted in Asia, then it would be easier for China to make the yuan an international currency in the future.

In its effort to boost the appeal of the yuan among other countries as a currency to hold as foreign exchange reserves, China had already signed trade settlement agreements with Mongolia, Vietnam, Myanmar and Russia among others to voluntarily use the yuan as a currency of choice to settle trade payments and had let Chinese banks issue yuan-denominated bonds in Hong Kong earlier this year.

With China's foreign exchange reserves rising at a rapid pace and standing at $1.89 trillion, the yuan had been getting greater acceptance from its neighbours in recent years and there has been many Chinese economist who were advocating making the yuan an international currency, with the weakening dollar having caused a decline in China's foreign exchange reserves.

China is now looking towards expanding the yuan to other financial markets by make the yuan fully convertible and giving yuan holder's investment channels and also allow the currency to enter the country freely for investment in stock or real estate.

Some Chinese experts are hesitant on fully converting the yuan citing the Asian crisis of 1998 where the country came unscathed because the yuan was not fully convertible under capital accounts and was also the main reason why it has not been affected fully in the current global financial crisis.

They also believe that by liberalizing the fund flow, the economy will be susceptible during regional or global economic crisis.